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Citi Capital Markets worries that the protest movement against the high cost of
living threatens Israel’s bond market as the government loosens fiscal
restraints to meet the protesters’ demands, thereby weakening Israel’s fiscal
position and forcing monetary tightening.

“A protest movement has evolved
in the past few weeks from a Facebook campaign that contested the price of
cottage cheese, to a tent city in Tel Aviv protesting the cost of housing, to a
broad populist movement which on Saturday night attracted 300,000 demonstrators,
or 4 percent of the entire Israeli population,” analyst David Lubin
said.

He noted that the protest movement has no formal links to any
political parties, and the issues that have brought protesters together are many
and varied. At the heart of the protest is a set of complaints about the cost of
housing, but plenty of other issues feature strongly, including the level of
indirect taxation, the size of fiscal transfers to ultra-Orthodox communities
and to settlers, the failure to improve Israel’s transport infrastructure, the
deterioration in the quality of education and healthcare, the size of Israel’s
defense budget, and the dominance of a small number of families in the structure
of Israel’s corporate ownership, he said.

Lubin believes that Israel
seems an unlikely candidate for a mass protest movement, as its democracy is
robust, and the performance of the economy has been almost exemplary.

But
in some ways it makes sense to think of this protest movement as some kind of
distant cousin of the Arab revolutions, he said, as Israeli protesters are
motivated, like their Arab counterparts, by a deep sense of injustice. He added
that the incidence of Israeli poverty is very high by OECD standards, while
direct tax cuts and a narrow structure of corporate ownership have helped to
underline problems of inequality.

The government’s response to the
protest movement whose momentum seems undiminished right now is evolving, but is
likely to lead to it is likely to involve structural reforms and fiscal
loosening, according to Lubin. The structural reform agenda is likely to include
measures to improve competition and reduce cartelization in a variety of
sectors. Possible areas of reform include the food industry, retail, banking,
cement and telecoms. In addition, measures to increase the effective supply of
land by reducing the dominance of the Israel Land Administration are also
likely. Structural measures could be good news for Israel’s growth potential,
but will take time. In the shorter run, fiscal expansion is likely to
dominate.

Lubin questioned whether Israel’s policy response to the
protest movement is consistent with the recent rally in Israeli fixed income.
Israel’s fixed income markets have seen a strong rally in recent weeks, and the
market is now barely pricing in any interest rate hikes over the next nine
months. “This seems wrong to us,” said Lubin.

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He concluded that even if
the public finance consequences of the protest movement are relatively modest,
Israel’s fiscal position is more likely to weaken than strengthen as a result,
and that will at least raise the question of whether monetary policy needs to be
tighter. And since the recent weakening of the shekel is more likely to be
inflationary than not, it seems unreasonable for the market to be pricing so
little in the way of rate hikes.

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